Refinancing your mortgage is a big decision, and for someone with access to VA benefits, there’s even more to consider. You have options available to you that people who are limited to conventional financing do not. When you refinance, you essentially pay off your current loan and replace it with a brand new one. Often this can extend your term, lower your monthly mortgage payment and also potentially lower your interest rate. The Veteran’s Administration offers two options if you are interested in pursuing a refinance of your home. The first is the IRRRL program, also knows as a VA Streamline Refinance or a VA to VA loan. The second option is a VA Cash Out Refinance, which allows you to convert equity in your house to cash.
VA IRRRL REFINANCE OPTION
If your goal is simply to lower your interest rate and you aren’t looking to take additional cash out of your equity, the VA IRRRL program is definitely the way to go. IRRRL stands for Interest Rate Reduction Refinance. This loan is also called a VA Streamline because the process is designed to be quick and easy. You can generally apply for and close this loan in under 30 days, whereas a traditional refinance can take upwards of 45 days or more. It’s designed to be an efficient way for you to replace your current VA loan with a new loan with a lower interest rate. The VA knows that you’ve already gone through most of the red tape when you applied for your original VA loan. You have your Certificate of Eligibility, done the credit process and you have a VA home appraisal. Since you aren’t allowed to take any additional cash out with this loan, the VA does not require another credit check OR have another appraisal done on your home. This saves a huge amount of time.
It’s worth mentioning again that you do not need any upfront cash to refinance using the IRRRL program. All loan costs can be rolled into the loan, making it a truly no cost up front refinance. Keep in mind that when you do that, you will be paying interest on those costs, as it does add to the loan balance. Most people find that an acceptable trade-off to realize the lower monthly payment.
People with an adjustable rate mortgage can also take advantage of moving to a fixed-rate loan with an IRRRL. With an adjustable rate mortgage, your payment can go up without warning stretching your monthly budget tighter than is comfortable. This is the only instance where refinancing may actually increase your interest rate but being able to lock your interest rate is usually worth it. Having the stability of knowing that your payments will not change throughout the life of the loan can give you a lot of peace of mind.
There’s one more benefit available with the IRRRL that we haven’t talked about. While you are never allowed to take any cash out of an IRRRL, you can add up to $6,000 in Energy Efficient Improvements to you home. You can add insulation or put on new doors and windows. Programmable thermostats and upgraded HVAC equipment would also qualify. You can have this work done either before or after closing. If you pay out of pocket, the lender will need proof of payment, and you have 90 days from the date of services to get reimbursed for the costs. A small word of caution on using this benefit. One of the draws VA loans offer is the ability to finance 100% of your home’s worth. Using this extra $6,000 could make your mortgage balance more than the cost of your home, which could make selling your home challenging down the line.
VA CASH OUT REFINANCE OPTION
The VA Cash Out Refinance, on the other hand, is just like it sounds. It allows you to tap into the equity of your house and draw cash out at closing. Not only can you use this option to get money for home
improvements, it could potentially lower the interest rate on your current loan. You can even refinance a conventional mortgage into a VA cash out loan. Let’s take a deep look into the VA cash out loan first.
A cash out refinance means you replace your current mortgage with a new one that is for more than your existing loan. When you close on the loan, you would get the difference in cash. This is not an additional loan or a second mortgage. It’s a new mortgage with a brand new, higher balance. You are allowed to use the cash for anything you like, however most people use it for one of three things: home improvements, education costs or debt reduction.
How does it work? Let’s look at some actual numbers. Assume your home appraises for $300,000 and your current mortgage balance is $175,000. You are looking to take out $75,000 in equity to repair the roof, fix the furnace and replace your deck. You go through the loan process based on a total new mortgage of $250,000 plus closing fees. At the closing, the lender will provide you with a check for $75,000 to use however you see fit.
Usually if you were to do this with a conventional refinance, lenders would require borrowers to maintain at least 20% equity in the home. That means if your home appraises for $300,000, the highest loan balance a lender will allow is $240,000. This does not hold true for you – because you are eligible for a VA cash out refinance. You have the backing of the Veteran’s Administration on your side. Using that $300,000 example, your total loan balance at the end of closing can total $300,000. You get the benefit of being able to withdraw more cash than others not eligible for the VA loan benefit.
There are always pros and cons when considering a VA loan cash out. You’ll need to look at both sides very carefully. It can be a really good option if you deem the circumstances are worth eating into the equity of your house. Here are some of the advantages of cashing out some of your equity:
· Interest rates may have fallen since you got your first mortgage. By lowering your interest rate, you may be able to take out needed cash while keeping your payments close to their current level.
· It can be a good way to get a large sum of money at a low interest rate. Home repairs and improvements can be very expensive. Not many of us have an extra $50,000 laying around to use, as much as we may aspire to. Taking the money out of your equity can be much less expensive than putting costly home repairs on a credit card or taking out a personal loan.
· If you use your cash for improvements to the house, the interest on the cash out portion of the loan is tax deductible. If you refinance your $175,000 mortgage and cash out that $75,000 to use on home improvements, not only is the interest on the original $175,000 tax deductible, the interest on the additional $75,000 is also tax deductible. This is not the case if you use the cash for other purposes, such as debt reduction. In that case, only the interest on the original $175,000 is tax deductible.
Disadvantages you may want to consider:
· If interest rates have gone up since you financed your home, you will be refinancing at a higher interest rate. This is going to be a big factor in whether you decide it’s worth taking out the cash. Not only will your payment potentially go way up, the cost of the loan will be much more expensive.
· You may be dragging out the repayment of your house. As you make your monthly mortgage payments, your equity naturally increases as your principal balance goes down. At the time of refinancing, you may be 15 years into your 30-year loan. If you refinance for a lower interest rate and take cash out on top, you start over at the beginning of the loan term. Instead of having your home paid off by the time you’re 60, you’ll be paying your mortgage until the age of 75.
· You run the risk of giving into the temptation to use your house as an easy source of cash. Especially with your military status allowing you to cash out up to 100% of your home’s value. You may be tempted to use the money on luxury items that are not financially sound reasons to tap into your home’s equity. You can easily over-extend yourself financially, increasing the risk of losing your home if the unforeseen happens.
Deciding whether or not to access your equity for cash is a very personal decision. One nice thing about cash out refi’s is that there aren’t any limitations on how you can use the money. Technically you can use it for anything. But in general, since you are borrowing against your home, it makes the most sense to use it to put yourself in a better financial situation.
WHY REFINANCE?
The number one reason people refinance is because the interest rate on their existing loan is higher than rates currently available. VA interest rates have stayed desirable throughout most of 2019, so if your interest rate is 5% or higher, it’s worth looking into. How much can you save with a lower interest rate? A rate that’s a full percentage point below your current mortgage will give you the most benefit. For example, a $150,000 loan at 5% interest will cost $805.23 per month. At 4%, that payment goes down to $716.12, saving you almost $90/month. Not sure if refinancing is worth it? Our loan specialists will review your needs and find a solution that is right for you.
IS THERE A DOWNSIDE?
With all this talk of saving money and getting cash to pay for necessities, you may wonder why people ever hesitate? There are two sides to every story, and there are important things to consider whenever you think about refinancing your home. Below are some of the big ones.
IT WILL TAKE LONGER TO OWN YOUR HOME
How long have you been paying down your current mortgage? Ten, fifteen, maybe even twenty years? When you refinance, you’ll most likely be starting over at the beginning of a new 30-year mortgage. Adding an extra 10 years or more before you pay off your home may not be desirable. Of course, you could always pay extra money each month toward the principal, but that requires a lot of discipline to do regularly. You may also be tempted to look at refinancing with a shorter-term loan. That would be great if you can do so, but make sure you look at what the monthly payment would be. Taking a 15-year mortgage instead of a 30-year can cause your monthly payment to be significantly higher than what you are currently paying.
IT’S NOT FREE
You also need to look at the costs associated with refinancing your mortgage. Not only are you extending out the length of your mortgage, you’ll also be adding to the balance. Although you may be able to refinance with little to no money down, you still will have additional costs to consider.
CLOSING COSTS
As you may already know, closing costs are comprised of various services lenders charge for as they process your loan. Recording fees, flood zone determination, title insurance fees, prepaid taxes and hazard insurance are included here. It also includes the Loan Origination Fee, which is not allowed to exceed 1% of the total amount of the loan. The origination fee is a lump sum combining administration fees such as notary, application and processing, document preparation, loan closing and more.
VA FUNDING FEE
The purpose of the VA Funding Fee is to reduce the cost of the program to taxpayers considering that there is no down payment or Private Mortgage Insurance associated with VA loan programs. It’s calculated using a percentage of the total amount of the loan. That percentage is determined on several factors, such as whether you choose to make a voluntary down payment, your military category and which type of refinance you decide to go with. For example, the funding fee is much less for an IRRRL loan than a Cash Out Refinance. You can read more about the VA Funding Fee here.
THE BREAK EVEN POINT
With these extra costs added on, how do you determine whether VA loan refinance is worth it? You’ll want to figure out your break-even point. In other words, how long will it take you to recoup the closing costs and the funding fee based on the monthly savings you receive after closing? Here’s an example. Say your current loan is $150,000 at 5% interest, costing $805.23/month. Your new loan, after refinancing, will be $150,000 at 4%. This lowers your payment to $716.12/month, saving you $86.11/month. If your total closing costs are $2,500, you divide that by $86.11 (the amount of your monthly savings after refi). You then see it will take you 29 months to recoup the amount you added to your loan for closing costs. As long as you are plan to live in your current house for at least another 2.5 years, you will be ahead of the game.
Depending on what your motivation is for refinancing, both options are excellent choices. National VA Loans is here to help you decide exactly which refinance option is best to fit your needs. For more information, call us at 855-956-4040.